Personal tax planning: Retirement, gifts and inheritances

In this article we discuss long-term tax planning for Israeli investors.

taxes good 88 (photo credit: )
taxes good 88
(photo credit: )
What about retirement tax planning? Retirement is relative of course - some successful people just can't let go and others just can't wait to start taking it easy. With regard to pensions received from abroad, an Israeli resident taxpayer generally may choose between two main Israeli tax approaches. If the taxpayer reached retirement age (as defined in the legislation - up to 67, generally) he or she may claim an exemption for 35% of the pension payments and pay regular Israeli tax rates on the remaining portion of the payments - resulting in a net effective income tax rate of around 32%. There is no upper limit for "unapproved" foreign pension payments - whereas tax benefits for pensions from "approved" Israeli pension and provident funds are subject to monetary and other limits. Alternatively, an immigrant to Israel who receives a foreign pension for work done in a foreign country may elect to pay the tax that would have been payable in the country where the pension is paid had they remained resident in that country. This rule leaves open a number of questions - how is the tax calculated if a person worked outside his/her country of residence or receives a pension from a country outside his/her country of residence. Furthermore, how are Israeli and foreign personal deductions or credits allocated if the individual has other sources of income in addition to the foreign pension? At present, it appears that any reasonable approach may be considered, provided adequate disclosure is made in any tax return. Immigrants from the US and some other countries should remember to claim an exemption from tax in those countries on pension payments to an Israeli resident. This applies to immigrants from a country that has a tax treaty with Israel, but check the terms of each treaty in each case. In the case of a US person residing in Israel, the US-Israel tax treaty exempts the individual from US federal tax (leaving tax payable only in Israel) on a pension or annuity paid following services rendered, injuries, sickness or self-employment. However, it has been ruled that the California State lottery prize payments made in installments are NOT annuities exempt from US tax under the US-Israel tax treaty - You can't win 'em all. What about receipts from an Individual Retirement Account (IRA) in the US or an RRSP (Registered Retirement Savings Plan) in Canada? If such retirement plans allow the recipient to decide or vary the amount he receives from the plan, officials at the Israeli Tax Authority have indicated they may treat these like a savings account. Under this approach, the income element may apparently be taxed at 20%, minus a credit for any foreign tax, while the capital element may not be taxable at all. Unfortunately, the Israeli Tax Authority has not yet issued a formal written pronouncement in this area, despite numerous requests over the years from taxpayers and politicians. In the meantime, if you are a recipient of such a variable payment account, you might consider which approach is best for you taxwise and disclose the approach you adopt on your annual Israel tax returns, if you are required to file them. What long-term planning is needed for gifts or inheritances? Gifts in good faith by an Israeli resident to relatives or others are exempt from Israeli tax unless the recipient resides abroad, in which case the gift may be subject to Israeli capital gains tax at rates of 20% to 49% in the case of an appreciated asset such as shares in a company. A gift of cash by definition cannot give rise to a taxable capital gain in any event. There is no inheritance tax in Israel and bequests are exempt from capital gains tax. Therefore, the transmission or receipt of a gift or inheritance in good faith is not reportable nor taxable in Israel. However, an Israeli resident recipient will pay capital gains tax at rates of 20% to 49% upon any subsequent sale of gifted or inherited assets, applying the donor's original cost. There are no express provisions for crediting foreign estate/inheritance tax or for "stepping up" (revaluing) the cost of such assets received. This can lead to double taxation unless early action is taken - use of trusts, receipt of cash rather than other assets, or application to the Israeli Tax Authority for concessionary relief (no assurances exist that such relief will be granted). Professional advice should be taken in all such cases sooner rather than later. If the donor is a US person, there may be a US gift or estate tax liability unless annual exemptions or the $1 million lifetime exemption ($2 million upon death) are used. In addition, smaller gifts of $12,000 starting per donor to each recipient per year are exempt from US gifts tax. Proposals exist in the US to raise these exempt amounts so that only the super rich pay the US estate or gifts tax. These proposals and any resulting legislation should be kept under review. There may also be tax consequences for a foreign donor in other countries - the UK, France, Germany, Belgium. A gift will not be in good faith if it is really a disguised business receipt. A gift can be made informally or formally recorded in a letter or even a deed of gift - sometimes it is prudent to record large gifts in a letter or a deed of gift, to avoid any suspicion that the gift is really a disguised business receipt. A gift can also be conditional, which can give rise to interesting possibilities in some cases. If the donor is a US person or the assets are US assets, then US estate tax can apply if that person passes away, at rates ranging from 18% to 46% in 2006; 45% in 2007-9; 0% in 2010; and 55% in 2011 onwards. Gift tax is also possible for certain US assets (not securities) gifted by non-US persons. A US person is entitled to give an unlimited amount free of US tax to a spouse who is also a US person. There are limits if the receiving spouse is not a US citizen, but tax may be mitigated by using a QDOT (qualified domestic trust). For Israeli tax purposes, if the donor resides in Israel, this should be an "Israeli Residents Trust." Such a trust will be taxable at the maximum Israeli tax rate (49% at present) unless a special tax rate applies without limit - such as 20% for most dividends, interest and capital gains. The trustee will be subject to an Israeli reporting requirement. Distributions to Israeli residents should be exempt. Distributions may only be subject to Israeli capital gains tax if they are to beneficiaries who are not Israeli residents. A non-US spouse may not want to make a direct gift to a spouse or kids who are US citizens or green card holders, having regard to US estate and gifts tax tax. Instead, they may want to consider carefully a lifetime or testamentary "dynasty trust" for the benefit of the US persons. Much will depend on individual circumstances and the assets concerned. The Israeli tax effect may thus be little or none and considerably outweighed by the US tax savings. Nevertheless, these possibilities should be checked fully with legal and tax advisors in each country. Note that some other countries may also impose a tax upon the death of Israeli resident investors who had investments or property in those countries, such as estate tax in the US or inheritance tax in the UK. This is a shame as the estate assets may be frozen by law for months or years while the taxes are calculated and paid. Moreover, the tax may often be mitigated or avoided entirely by structuring the investment appropriately at the outset, in conjunction with advisors in each country. The writer is an International Tax Partner at Ernst & Young Israel (With thanks to Ed Rieu of the Ernst & Young U.S. Desk, London)